BEIJING (Reuters) - Activity in China's factory sector contracted in January for the first time in six months, a preliminary survey showed on Thursday, pointing to a weak start for the economy in 2014 as policymakers seek to curb high debt levels to head off financial risks.

Weighed down by weaker domestic and export demand, the flash Markit/HSBC Purchasing Managers' Index (PM) fell to 49.6 in January from December's final reading of 50.5, dropping below the 50 line which separates expansion of activity from contraction.

The data is the first indication of sentiment in the 56.9 trillion yuan economy, the world's second-largest, for the new year.

"Such a reading highlights the deteriorating growth outlook as policymakers are tightening their monetary stance, pushing through with an austerity campaign, and withdrawing stimulus measures," said Dariusz Kowalczyk, a senior economist and strategist for Credit Agricole CIB in Hong Kong.

"The reading points to a further slowdown in manufacturing and the entire economy in Q214. We maintain our below-consensus forecast for 2014 GDP growth of 7.2 percent."

The Australian dollar dropped to a session low of $0.8800 from around $0.8838 just before the data. China is Australia's single biggest export market.

Rising money market rates and bond yields since the middle of last year indicate China's central bank is committed to deleveraging in the economy to fend off potential risks, but it has so far refrained from tightening policy abruptly.

"This implies softening growth momentum for manufacturing sectors, which has already weighed on employment growth. As inflation is not a concern, the policy focus should tilt towards supporting growth to avoid repeating growth deceleration seen in 1H 2013."

The flash PMI showed a faster rate of decrease in new export orders and employment in January. The new orders index came in at 49.8, the first contraction in six months.

PMI surveys at the end of last year had confirmed slowing momentum, with the HSBC/Markit one showing a three-month low and the government's official PMI at a four-month low. Both cited weak new export orders as one of the main reasons for the dip.

A Reuters visit to southern China's manufacturing heartlands this month showed many factories have closed earlier than usual for the upcoming Lunar New Year, the nation's biggest holiday, discouraged by weak orders and rising costs.

Some analysts said the holiday may have influenced the weak activity figures, but others were more cautious.

"There are no strong seasonal factors in January - sentiment has increased in every January over the past 5 years," Kowalczyk said.

"There is, theoretically, a possibility of a Lunar New Year effect, but even in 2012, when the holiday also fell in January, the HSBC PMI rose. Hence, we assume that the weakening of mood is cyclical and reflects underlying weakening of growth momentum."

REBALANCING ACT

Chinese leaders have pledged to push reforms to unleash new growth drivers as the world's second-largest economy loses steam, burdened by industrial overcapacity, piles of debt and soaring house prices.

That means reducing government intervention to allow market forces to have a bigger say in allocating resources, and promoting domestic consumption at the expense of investment and exports.

China's annual economic growth slowed to 7.7 percent in the fourth quarter of 2013 from 7.8 percent in the previous quarter, putting full-year growth at 7.7 percent, sightly ahead of the government's target of 7.5 percent.

While the economy narrowly missed expectations for full-year growth to fall to a 14-year low in 2013, some economists say a further cooldown will be inevitable this year as officials hunker down for difficult reforms.

Still, most economists believe the slowdown will be modest and expect 2014 full-year growth will be between 7 percent and 7.5 percent.

Sources with top think-tanks have said the government likely will stick with the 7.5 percent target this year, indicating the leadership is still keen to keep the economy on an even keel as they push reforms.

Premier Li Keqiang said in a written address to the World Economic Forum in Davos that China will continue to deepen reforms and maintain steady economic growth this year, and also take more forceful measures to boost employment.

The HSBC/Markit PMI is more weighted towards smaller and private companies than the official one, which contains more large and state-owned firms.

The final HSBC/Markit manufacturing PMI for January is due on January 30 and the official manufacturing PMI is set for release on February 1.

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